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Question: 05. How could a CBDC affect financial stability? Would the net effect be positive or negative for stability?
Question
- How could a CBDC affect financial stability?
- Would the net effect be positive or negative for stability?
Answer
Overview
To answer these questions, it is important to first have a good working definition of Financial Stability.
- Financial Stability reflects the ability of the financial system to consistently supply the credit intermediation and payment services that are needed in the real economy if it is to continue on its growth path.1)
When defining concepts like stability and the things that affect and maintain, providing to define the opposite definition (i.e., Financial Instability).
- Financial Instability occurs when problems (or concerns about potential problems) within institutions, markets, payments systems, or the financial system in general significantly impair the supply of credit intermediation services - so as to substantially impact the expected path [growth path] of real economic activity.2)
How could a CBDC affect financial stability?
Eric S. Rosengren discusses the process (i.e., Model) of propagating Financial Instability, see Figure 1. There are two major factors presented in the diagram: Increase In Uncertainty and Deterioration in banks’ Balance Sheets which are pertinent to a U.S. CBDC and can trigger the propagation of Financial Instability (i.e., the opposite of Financial Stability). These concerns are also echoed n the Executive Summary of the Money, and Payments: The U.S. Dollar in the Age of Digital Transformation or White Paper.
Increase in Uncertainty
- For a nation’s economy to function effectively, its citizens must have confidence in its money and payment services. The Federal Reserve, as the nation’s central bank, works to maintain the public’s confidence by fostering monetary stability, financial stability, and a safe and efficient payment system.
The part of the statement that “citizens must have confidence in its money and payment services” emphasizes one of the triggers described by Rosengren's Model, “Increase In Uncertainty”.
Some of the “Uncertainty” introduced by a U.S. CBDC to the financial system have been defined by the White Paper and already discussed in Question: 10. How should decisions by other large economy nations to issue CBDCs influence the decision whether the United States should do so?.
| Statement No. | Statement | Comment |
|---|---|---|
| R0003 | Risk to the safety and stability of the financial system | If there is a major hack to the CBDC, this could trigger a “lack of confidence” not just in the CBDC, but in the U.S. Dollar and perhaps The Federal Reserve. |
| R0005 | New payment services could pose Risks to:
| If there is a major hack to the CBDC, this could trigger a “lack of confidence” not just in the CBDC, but in the U.S. Dollar and perhaps The Federal Reserve. |
In addition, many additional risks to the “Uncertainty” introduced by a U.S. CBDC to the financial system have already been discussed in Answer to Question: 11. Are there additional ways to manage potential risks associated with CBDC that were not raised in this paper?:
Deterioration in banks’ Balance Sheets
Table 2 lists some highlights from some other Answers the OMG's CBDC WG members have already answered. regarding “Deterioration in banks’ Balance Sheets”.
Would the net effect be positive or negative for stability?
Overview
As the question states, there are positives and negatives on both sides. The OMG's CBDC WG answers to a couple of the White Paper have already addressed some of these issues. Obviously, the overall goal is to have overwhelmingly more positives than negatives. AT this point negatives and positives are purely speculative without further understanding of exactly what the U.S. CBDC will be.
For example, in the “desirements” identified by Object Management Group's CBDC WG from the White Paper and summarized in the OMG's CBDC WG White Paper Analysis are used as the basis for the ambivalent answer. From the “desirements”, it appears that there are two main sets of requirements when it comes to determining potential interest payments. Each of the sets is dependent on how the CBDC is to be modeled:
- Cash Model - these are requirements with CBDC characteristics most closely aligned with a simple cash model
- Account Model - these are requirements with CBDC characteristics most closely aligned with the account model (i.e, savings, checking, investment, direct pay, credit, debit cards, etc.)
It is only through System Engineering including a proper requirements analysis that CBDC can be defined. It may also be determined that the CBDC could actually represent two different things that need to be developed independently but in parallel. Without this analysis, all positives or negatives are merely speculative and reflect the understanding, biases, and prejudices of the individuals.
Summary
In summary, determining the “positives” and “negatives” is dependent on the management of the U.S. CBDC Systems Engineering process, how well it is monitored and how well it can adapt over time. Note: One stakeholder's positive is another stakeholder's negative. For example, abiding by the Privacy Laws and Regulations is highly desirable from the End User perspective, but not from Law Enforcement.
